Market Commentary - June 2018

Much has been written about the negative impacts of rising rates on the markets. Let’s look at some positives...

Currently, global pensions assets total about $41.3 Trillion and many of the largest pensions hold 25% to 50% in bonds and cash. With interest rates at record low levels for the last decade, pension plans felt the pain as a large portion of their portfolios were yielding minimal returns. On average, pension funds may benefit as every 1% increase in interest rates equates to 12% to 14% decrease in plan liabilities. While it's true they have benefited from equity market gains over the past decade, returns on a diversified portfolio have been weighed down by the low returns on bonds/cash and the underperformance of commodities, European and Emerging market equities vs. a pure U.S. equity portfolio.

Retirees also benefit as rates on savings accounts, money markets & CD's increase. It seems like forever ago, but CD's were yielding approximately 4% in 2008. This is significantly higher than what we saw from 2010 to 2017. Retirees will earn more interest which in turn aids cash flow and helps to provide some protection against future inflation.

In addition, a decade of low interest rates forced long term care insurers to significantly increase premiums. It is estimated that every 1% decline in rates lead to a 10-15% increase in premiums. With rates increasing, long term care premiums will hopefully remain steady and that helps retirees who are a majority of long term care insurance policy holders.

Real estate could also see a benefit as the prospect of higher sustained rates may compel some to make a home purchase sooner rather than later which in turn could increase demand and prices.

Lastly, while this may sound counter intuitive, rising interest rates can be beneficial in preventing an economy from over heating. Higher interest rates tend to reduce speculation as the cost of borrowing dampens the potential gain.

Many argue, myself included, that the federal reserve waited too long to increase rates. Now it seems they are set for 3-4 annual hikes over the coming years. While there will be bumps in the road, the path to normalization is long overdue. If earnings and economic growth continue to chug along, things might not be as bad as many thought. The truth is, no one knows how this will all play out and it's important to remember that volatility is normal, and the lack of volatility in 2017 was abnormal. While volatility isn't necessarily fun, it is normal and part of what makes markets what they are.